The Importance of Location When Buying a Rental Property
Location location location… Sounds familiar? It should – that is, if you are a real estate investor or anyone somehow related to the real estate business.
No wonder experts claim that location is the single most important variable when searching for and buying a rental property. While location will determine many of the factors for the success of your investment property, it is a constant, which means that you cannot change it unless you decide to sell your property.
However, we don’t want to simply claim that the place where your income property is located is so important. Instead, we will show you the reasons why location is the #1 factor to consider when buying an investment property. Moreover, we will provide you with some hints on how to choose the best location for a rental property in 2018 and beyond.
Why Is Location So Important for the Success of a Rental Property?
Location determines the property price
Whether you are a new real estate investor or an experienced one, financing your investment properties is definitely a major concern. You have a limited budget, and you have to make sure that you buy the best possible income property within this budget.
But what exactly does location mean in real estate investing? Is it the country? Is it the state? The city? The neighborhood? It is all of these! Let’s look at an example.
Many are looking into property investment opportunities in the California real estate market in 2018. Both Oakland and San Francisco are major cities in Northern California. According to data from Mashvisor, an advanced real estate analytics tool, in May 2018 the average property price in Oakland was $869,800, while it was $1,623,000 in San Francisco. This is a difference of nearly 100%, equivalent to $753,200, for a distance of around 10 miles.
That’s not even the end of the story. Location is a crucially important factor not only between cities but also within cities, as Mashvisor data shows. In Oakland, the average property price in the Cleveland Heights neighborhood was $549,000 in May 2018, compared to $4,995,000 in Merritt. Similar differences exist in San Francisco, where the average property price in the Little Hollywood neighborhood, the cheapest one in the city, was $864,000, while it was $2,837,300 in North Beach, the most expensive neighborhood.
So, as you see, first and foremost, the location of your future rental property will determine how much you will have to pay for it. A great website to reference for our friends in Canada is Precondo, they will give you an indepth look into the key markets.
Location determines the supply of and demand for rental properties
The way rental property investors make money is by renting out their properties to tenants, so a major factor in your investment decision should be how easy or hard it will be to rent out your investment property. Once again, location is the primary determinant of this.
Location dictates the rental demand and the rental supply in a real estate market. Naturally, places with a strong economy, low unemployment, and growing businesses will face a high demand for traditional (long-term) rental properties. Meanwhile, if the economy is generally performing poorly, not many people will be looking for income properties to rent in this location.
Another important indicator of the rental demand is the price to rent ratio within the city. The price to rent ratio, an important real estate metric, is the average property price divided by the average annual rent in a certain market. Housing markets with high price to rent ratios are simply too expensive for people to buy homes, so they resort to renting, while locations with a low price to rent ratio will generally experience lower rental demand. Real estate investors and landlords should thus look for markets with price to rent ratios of 21 and above when deciding where to buy a rental property
Location determines the type of tenants you can expect
If your rental property is located next to a college or university, you can expect to attract a lot of faculty and students. If you buy a condo in a busy city center, chances are your tenants will be single professionals or young families. If, on the other hand, you invest in a townhouse in the suburbs, you will mostly face demand from families. We are sure you get the overall idea: location determines not only how many potential tenants you will have but also with what type of tenants you will have to deal.
Location determines the optimal rental strategy
Let’s go back to what we said a couple of lines up. Locations with strong economic development attract a high demand for traditional, long-term rentals. At the same time, places which are rich in tourist attractions are excellent locations for vacation homes, or short-term rentals. This is common sense and does not require expertise in real estate investing.
Data provided by Mashvisor also shows that the return on investment a real estate investor can expect in a certain location depends largely on the rental strategy that he/she will employ. If we go back to the California real estate market, Joshua Tree is gaining more and more popularity as a top tourist destination in recent years, while it does not offer any employment opportunities. This makes it an ideal location for short-term rentals, which enjoy a cap rate of 6.7%, compared to only 1.0% for traditional rentals.
So, where you decide to buy your investment property will dictate the optimal rental strategy with which to go.
Location determines how much rent you can charge for your property
When you set the rent on your income property, you have to take into consideration a number of factors including the rent which other comparable properties charge in the area, the rental demand, the average household income, the local cost of living, etc. All these are greatly affected by location, which correspondingly means that the location of your investment property will determine how much rent you can charge for it.
For example, the average rental income of a real estate investor in San Francisco was $4,780 in May 2018, while it was $3,440 in Sacramento. So, before you decide on where to invest in real estate this year, keep in mind that the location will determine how much money you will make from your rental property.
Location determines the return on investment you can expect
The return on investment in any kind of business is basically the difference between the money you invested and the money you made. The same holds true for real estate investing. Thus, it is only logical that the price you have to pay for your investment property and the rent you will collect from it will determine what your return is. Since both inputs are largely affected by location, so will be your return on investment as well.
Cap rate, defined as the net operating income over the current market value of a property, is one of the major return on investment metrics in real estate. According to Mashvisor’s real estate market analysis, the average cap rate for short-term rentals in San Francisco is 1.0%, compared to 0.1% in Oakland. Meanwhile, it is as high as 6.7% in Joshua Tree.
This means that it does not suffice to decide that you want to invest in California real estate. You have to be more specific and decide in which city you want to buy a rental property. Then you have to perform neighborhood analysis and settle on a neighborhood in which to invest. In San Francisco, a real estate property rented out on short-term basis can bring you a cap rate of 0.5% in Duboce Triangle or of 2.4% in Little Hollywood. The differences in some other cities are even starker. All this means is that you have to be as specific as possible when you choose the location of your next investment property.
Now that you understand exactly how important location is in real estate investing, we don’t want to leave you hanging there. We want to take you a step further in your real estate investment decision by providing you with tips and tricks on how to choose the best place to buy a rental property in 2018 (and beyond).
How Do You Choose the Best Location for Buying a Rental Property?
You should do a lot of research
Real estate investing is a business and an investment like any other, which means that knowledge is power. The first step to selecting a top market in which to invest in real estate is conducting thorough research by reading as many economic, business, and real estate resources as possible. Start out by reading about the general state of the real estate market in the US at the moment and then gradually focus on specific states and cities which perform better than the rest. Always use up-to-date resources as the housing market is a very dynamic one and might change overnight.
You should narrow down and deepen your research
After you have been able to identify a few locations which seem to be particularly profitable for real estate investments at the moment, you should focus your research efforts on them. Remember to study the local market well. Keep an eye on the following indicators:
- Crime rates: Safety is a priority for all of us. Few tenants of doubtable character will want to rent your property if it is located in a place with high crime rates. Moreover, your investment might become a subject to robbery if the location is unsafe.
- Access to transportation: Good locations for investing in real estate are in proximity to public transportation and to transportation infrastructure. Even within the neighborhood, if you buy a property which is a couple of minutes away from the bus, this will play a major positive role when you try to rent it out and will allow you to ask for a slightly higher rent than if your property was located 20 minutes away from the bus stop.
- Access to amenities: Schools, hospitals, shopping areas, entertainment options, etc. – These all are important amenities and public goods, and you want to make sure your rental property gives easy access to them for your tenants. This will affect positively both the rental demand and your rental income.
You should conduct real estate market analysis
Once you know that your selected location is good in general terms, you have to dig into the real estate data. Make sure you conduct a thorough real estate market analysis of your location of choice. This will show you the average property price and point out whether you can afford to buy a property in this place. Moreover, you will gain insights into the average rental rates, rental income, and even return on investment, which will allow you to judge if it makes financial sense in the short term to invest in this place. Remember to always go for locations which promise you positive cash flow immediately. Don’t fall for the trap of investing for appreciation only.
You should study the future perspectives of the location
Now that we have mentioned appreciation, we can take a more detailed look at it. Appreciation is a major benefit of real estate investing as few other income generating assets increase in value just because of time passing. Thus, when you decide where to buy an investment property, you should look for a place which not only offers a high return on investment at the moment but which is expected to undergo some developments in the medium and long term. This will assure that your property will experience natural real estate appreciation so that you are able to sell it for a lot more than its initial price when you decide to do that in a decade or two.
You should use the power of data
We live in the era of big data, which real estate investors should use in their investment decisions. Technology has changed the face of the real estate investing business immensely in recent years, and every investor who aspires to succeed in this business needs to take the changes into consideration. A rental property calculator is a must-have tool for successful real estate investors.
You might wonder what a rental property calculator is…
A rental property calculator, also known as an investment property calculator, is an online tool which provides investors with the costs of investing in a particular neighborhood or even a particular property as well as the rental income expected from this investment. As a result, investors get an easy access to reliable estimates of their return on investment in a particular location in terms of rental income, cash flow, cap rate, and cash on cash return. The estimates are reliable because a rental property calculator uses both traditional and predictive analytics to come up with the profitability metrics based on big data. This tool eliminates the need to collect data on dozens of comparable properties in order to conduct comparative market analysis and saves investors weeks or even months of work.
Real estate investing is one of the safest ways to make money in the business world. Because real estate properties are physical assets, it’s hard to lose all your money unlike when investing in stocks, for example. However, return on investment can vary a lot from one real estate investor to another and from one investment property to another. The main determinant of profitability in real estate investments is location. After all, it is not without a reason that real estate experts consider location location location as the three most important factors for success. To make sure that you invest your money smartly, always choose carefully the place where you buy your next rental property. Do diligent property research, use the right tools, and you will soon be on the path of becoming a successful real estate investor with strong cash flow.
Daniela Andreevska is Content Marketing Director at Mashvisor, a real estate analytics tool which helps real estate investors quickly find traditional and Airbnb investment properties. A research process that’s usually 3 months now can take 15 minutes. We provide all the real estate information in easy to understand visualizations.